Global Pension Index Ranks U.S. ‘Below Average’

By Stephen Miller
10/22/2009

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The U.S. retirement income system ranks sixth out of 11 countries in the first global pension index that compares pension systems (private and public/government) across five continents. Produced by HR consultancy Mercer, the Melbourne Mercer Global Pension Index ranks retirement systems based on their adequacy, sustainability and integrity. “Clearly, U.S. policymakers and the private sector are grappling with the challenge of balancing the adequacy of benefits with the sustainability of public and private pension plans,” says Arthur Noonan, a senior consultant and actuary in Mercer’s retirement, risk and finance business.

Even though the sustainability of U.S. pension plans is greater than in countries with a more rapidly aging population or more generous benefits, the funded status of U.S. defined benefit plans remains a concern. “Expense and cash funding of defined benefit plans is likely to continue at historically high levels,” Noonan says, adding that the U.S. is challenged to improve the adequacy of pensions as its workforce reaches traditional retirement age and as the tough economic climate causes companies to reduce or suspend 401(k) matching contributions and freeze or close defined benefit plans.

Adequacy

The U.S. ranked ninth in terms of “adequacy of benefits”—how much income is available to a retiree. Among the factors making up the index, this is given the greatest weight. The U.S. score of 49.2 compared with Japan’s score of 39.2 at the bottom of the rankings. The Netherlands (80.5) and Canada (76.2) scored highest in this index because of the level of minimum public pension and a relatively high net replacement rate of income for median-income earners.

According to Noonan, the overall index value for the U.S. system could be increased by:

• Adjusting the level of mandatory contributions to increase the net replacement for median-income earners.

• Creating a minimum access age so that it is clear that benefits are preserved for retirement purposes.

• Introducing a requirement that part of the retirement benefit be taken as an income stream.

Sustainability

The U.S. ranked higher in the category of sustainability of its retirement system, with a score of 69.4, placing it third among the 11 countries in the index. Only Sweden, with a score of 75.2, and Australia, with 71.0, ranked higher. In measuring sustainability, the index considers such factors as the demographics of the population (ratio of productive workers to retirees), the funding status of pension plans relative to pension liabilities and level of government debt.

“The funding of defined benefit plans in the U.S. remains a challenge,” says Noonan. Mercer estimates the funded status of plans for S&P 1500 companies declined from 84 percent at the end of the first quarter of 2009 to 81 percent at the end of third quarter 2009, despite strong equity market performance.

“We anticipate that many plan sponsors will face substantial increases in their required cash contributions in 2010,” Noonan notes. “Funding issues also affect public-sector pension plans and, longer term, the funding of Social Security is an issue.”

Integrity

The index takes into consideration the integrity of private pension provisions, which is important in maintaining the community’s confidence in the system. Based on an assessment of four key areas—prudential regulation, governance, risk protection and communication—the highest-rated countries for the integrity sub-index were the Netherlands (88.2), Australia (87.8) and the U.K. (86.3). The U.S. ranked seventh with a score of 63.4.

Common Challenges

No country in the index was classed as having an “A” grade system (obtaining a score greater than 80), proving that even the world’s most advanced pension models still need refinement to ensure that they are robust enough to support the world’s rapidly aging population.

The countries with the lowest-ranking retirement income systems were Japan (with a score of 41.5), China (48.0) and Germany (48.2). While these countries don’t fall into the lowest grade of “E,” which corresponds to a score below 35, the efficacy and sustainability of their systems will be in doubt if major weaknesses are not addressed, says Noonan.

David Knox, worldwide partner in Mercer’s retirement, risk and finance consulting business, who oversaw the study, adds that global results indicate a need to address common challenges.

“The fact that no country achieved an “A” grade classification confirms that no one system is perfect or currently robust enough to withstand the challenges presented by an aging population,” Knox says. “The best arrangements for a particular country will depend upon its individual social, economic, political, cultural and historical context. However, by examining common and desirable characteristics of a retirement income system, lessons can be learned by governments to help them better prepare for demographic change and ensure older citizens have access to adequate incomes in retirement,” Knox notes.

The table below shows the overall index value for each country, together with the index value for each of the three sub-indices—adequacy, sustainability and integrity. Each index value represents a score between 0 and 100.

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